SANDEEP BAMZAI: Diageo may be Mallya's crutch

The spiral dive in aviation parlance has also been equated with the death spiral. Kingfisher is on a ventilator in an ICU, gasping and fighting for survival. Its flying licence ends on December 31, 2012.

The temporary lockout has been extended simply because there is no resolution in sight. The employees are refusing to fly till they are paid their dues, the management doesn't seem too keen to continue, the ministry and the regulator believe that putting the bird in the sky entails jeopardising the lives of the passengers.

Certificate of air worthiness cannot be issued because the airline's eco-system has collapsed.

The downward spiral in the airline's operations is so severe that right now, it nestles in the deepest recesses of a very dark abyss of gloom and doom. In aviation parlance, the tailspin appears to be complete.

Can it recover? Kingfisher is gasping and fighting for survival

Financials

It must be hurting Vijay Mallya's ego. Bruised and battered, he seems set to offload equity in one of his liquor firms United Spirits to bulge bracket spirits maker Diageo. The objective of the exercise is one of single minded focus: Funds infused via the deal will help de-leverage the balance sheet.

The question is how many Vijay Mallya group balance sheets can be de-leveraged through this modus operandi. If the government decides to offer euthanasia to the ailing carrier, then it may be good news all around.

Fortunately or unfortunately India doesn't have any bankruptcy laws, there is no equivalent of Chapter 11 handholding here. The financials are in a shambles - as of March 31, 2012, Kingfisher Airlines' total debt is Rs 8030 crore, its net worth has eroded eons ago, standing at minus 5082 crore, net losses for the financial year are at Rs 2328 crore, while first quarter ending June 2012 has a net loss of Rs 650 crore.

Tactics: Will his latest business ploy save Kingfisher for Vijay Mallya?

Believe me, nobody wants to be in that cockpit for sure. Promoter shareholding is down to a low of 35.86 while Foreign Institutional Investors have fled the counter for obvious reasons. As of June 2012 quarter, they hold under one per cent equity. Which tells you the investor community has lost faith in the counter.

Even as the nuts and bolts of the
deal are being hammered out between Mallya's flagship United Spirits Ltd
and Diageo, the stock continues to fly.

On
Tuesday, it closed Rs 51 higher, hoping against hope that the deal
would come through sooner rather than later. At Rs 1275, USL's market
capitalisation is a healthy Rs 16,682 crore.

Now let us work the math. It closed the March ending 2011-12 financial with revenues of Rs 7660 crore and a net profit of Rs 343 crore. It is VJM's prized asset. His quarterly revenues ending June 2012 were a hefty Rs 2072 crore, showing growth and resilience. Annualised, it will result in revenues in excess of Rs 8500 crore while full year profits too would be in excess of Rs 580 crore, a strong growth over the previous financial year.

Deal Markets work on the basis of prospective or forward earnings. They work on the premise that cash flows will be healthy and substantive. The problem is that as the promoter VJM doesn't have too much room to manoeuvre with. He owns only 27.78 per cent of USL. Does his exit from USL allow him to extricate himself from the morass that he has got into?

It must be with a very heavy heart that VJM will be signing on the dotted line, but as his list of choices shrinks rapidly, he just has to go ahead and swallow the bullet. Many rash decisions, including entering the aviation business, which is a mug's game in any case, will cost him his crown jewel if the deal with Diageo fructifies.

The deal is complicated because of VJM's 28 per cent stake in United Spirits, part of the 18 per cent held by holding company UB Holdings is pledged to lenders that funded its $1.2 billion 2007 acquisition of Scottish spirits maker Whyte and Mackay.

The promoters of USL - UB Holdings - will sell around 77.5 per cent of their 18.03 per cent stake, in USL. In the second tranche, Diageo will buy 2.64 per cent of treasury stocks of USL. What is the sum total that will eventually flow into Mallya's kitty is not clearly understood. If he gives up control, then he will charge control premium.

At its present valuation of over Rs 16,000 crore, he is likely to get anything between Rs 1400 crore and Rs 1500 crore. The lenders who hold some of the shareholding will also receive part of the proceeds.

Aviation is a difficult business, and it may yet prove too much for VJM

Outcome

Recently it was reported that ratings agency ICRA, downgraded the company's rating for delay in debt servicing as there is no certainty that these discussions will lead to a transaction. This essentially means that loans to United Spirits have been downgraded to junk status.

This downgrade could however force a transaction, failing which lenders would turn wary of funding even the liquor business. Diageo's entry can help it lower the debt burden, which is crucial as interest ate away half its operating profit.

Pertinently, United Spirits has total debt of Rs 3445 crore on its books as of end March 2012. The deal is definitely on the table, both parties have confirmed the dialogue. What it will finally result in for VJM and his ailing empire is still not clear. His immediate problems are statutory obligations which are mandatorily meant to be fulfilled. Some of this cash can be used for this purpose.

A top analyst at Sanford Bernstein, Trevor Sterling quoted on this deal said, "They would only buy a business if they saw a route to long term control of the business. There will be competition issues to look into – notably the future of Whyte & Mackay, the Scottish whiskey business that United Spirits acquired back in 2007, which Diageo may be forced to sell should a deal go ahead. It's a delicate balancing act for Diageo."

VJM has been a combative businessman and for long years very successful. Blinded by the lure of aviation, he has bitten off more than he could chew with Kingfisher. The chickens have now come to roost.